Two Countries, One System: How the Unique Model of China and Hong Kong Works

The “one country, two systems” model has for many years remained one of the most unusual legal and economic frameworks in the world. The concept was originally proposed in 1982 by Deng Xiaoping as a solution to the issue of Taiwan’s return. In practice, however, it was implemented through the return of Hong Kong and Macao to Chinese sovereignty.

This model became an unprecedented milestone in political history, as it marked the first instance of the coexistence of a socialist system at the national level and a capitalist system in specific regions within a single state.

More than 26 years after the model was first applied, Hong Kong has consistently maintained high positions in international competitiveness rankings. For over a decade, it ranked among the world’s leaders in capital raised through initial public offerings (IPOs), reinforcing its status as one of Asia’s key financial centres. In global financial rankings, Hong Kong traditionally ranks just behind financial capitals such as New York and London.

Macao, which returned to Chinese sovereignty 24 years ago, has also become a successful example of the “one country, two systems” principle in action. In 2019, Macao ranked second in the world in terms of GDP per capita.

But what does the principle of “one country, two systems” mean in practice? In this article, we examine how this model functions, the key differences between mainland China and Hong Kong, and why Hong Kong remains one of the most important international financial hubs.

As noted above, this principle was introduced to integrate Hong Kong into China while preserving its economic and legal autonomy. Formally, Hong Kong is part of the People’s Republic of China; however, it retains its own legal system (English common law), an independent tax and financial regime, its own currency, and autonomous regulation of commercial activities and corporate law.

In practice, Hong Kong operates as a separate economic jurisdiction despite its political affiliation with China.

Despite significant efforts by the PRC to integrate Hong Kong into the national system, fundamental differences between mainland China and Hong Kong remain.

These differences are most evident in the legal system. Mainland China applies a continental socialist legal framework, while Hong Kong continues to operate under English common law, characterised by transparent judicial procedures and predictable legal practice. For international businesses, this translates into a higher level of legal protection in Hong Kong.

Another important distinction lies in taxation and currency regulation. Hong Kong is well known for its simple, territorial tax system. It does not impose dividend tax or capital gains tax, and profits sourced outside Hong Kong may be exempt from taxation, provided certain conditions are met.

In mainland China, the overall tax burden is significantly higher and regulation is more stringent. In addition, the PRC enforces strict currency controls. Hong Kong, by contrast, allows free movement of capital and imposes no currency restrictions, which is why it is frequently used as a transit and holding jurisdiction for international transactions.

The successful implementation of the “one country, two systems” model has resulted in Hong Kong’s strong and consistent performance in global rankings:

• No. 1 in the world for economic freedom
• No. 1 in financial system development
• Ranked among the top 10 most competitive economies globally
• One of the leaders in business-friendly tax systems
• Among the world’s leaders in IPO volume
• One of the most business-friendly cities globally
• Ranked highly in Asia for judicial independence

Today, Hong Kong remains a global financial and business centre, home to more than 9,000 foreign and Chinese companies. It is also a major media and publishing hub in Asia and an international city for living, working, and investing, connecting global markets in finance, trade, and logistics.

In practice, international corporate groups often adopt the following structure:

• Chinese company — operational activities (manufacturing, sales, service provision)
• Hong Kong company — holding functions, equity ownership, dividend distribution, investments

This structure may allow companies to:

• reduce dividend tax burden (subject to applicable double tax treaties);
• simplify investor attraction and financing;
• increase credibility with banks and international partners;
• centralise asset management within the group.

It is important to emphasise that such structures require compliance with economic substance requirements and proper tax planning.

The “one country, two systems” model remains one of the key advantages for international businesses operating with China. Hong Kong continues to serve as a bridge between the Chinese market and the global economy.

Planning to use a China + Hong Kong structure for business or investment purposes?

We can help assess the applicability of this model, its tax implications, and economic substance requirements, as well as provide full support for company registration and ongoing administration in Hong Kong.